Will Digital Banking Make Depositors Antsier than Ever?

The Motorola Razr flip phone was considered the cutting edge of technology the last time rates were on the rise. Clearly, technology has changed. But have depositors' habits changed, too?

At some point, rates are bound to start rising after a long slog at nearly zero. When they do, they will be rising in a completely different world — one where more than a quarter of new accounts are opened outside of a bank branch, according to a recent Aite Group study, and where a slew of fintech startups are trying to make new account openings super quick.

The way people bank today is hugely different than it was in 2004, the last time rates climbed. Because of all the change, banks can't rely on past rate increases for cues on customer behavior, observers say. "This is a situation that might invoke John Templeton's statement that the four most expensive words in the English language are 'this time it's different.'" said Christopher Donat, an analyst at Sandler O'Neill, in a recent research note. In this case, "we don't think that the behavior of financial institutions and depositors will be the same as in prior interest rate cycles."

If Donat hedges, Dan Geller, head of Analyticom, a financial analytics firm, leans in. This time it will be different, he said.

"There is no historical precedence because digital banking was in its infancy in 2004," Geller said. "Connectivity, interactivity and speed have changed the paradigm completely."

The clearest example of how the adoption of digital banking is going to shape the next rising rate environment is the empowerment of the rate hoppers – the often-loathed bank customers who are really just looking for the bank that will give them the most bang for their bucks.

This group, observers say, will be able to move their money from bank to bank easily because that has become a quick and easy task. That could make the pricing competition on instruments like certificates of deposits increasingly fierce, Donat said.

In a recent research note, Donat focused on "cyber deposits" — those held in banks with no or limited branch networks, such as Capital One, USAA, Ally Financial and the brokerage firms like Charles Schwab and E-Trade. While overall deposits have grown at a compound annual growth rate of 6% in the last decade, cyber deposits have mushroomed at a rate of 20%, he noted.

The cyber deposit players are likely to move quickly in a rising rate environment, but mainstream banks have made their digital channels a priority and may likely be better situated — or more compelled — to compete than they were in the last rate cycle.

"The cyber deposit guys are likely to move quickly for business reasons and that may cause the traditional banks to move quickly, too," Donat said. "It might accelerate the response time to a rate increase."

Ron Shevlin, director of research for Cornerstone Advisors, said worries that the widespread use of digital banking could accelerate rate-hopping are likely "overblown."

"There was plenty of account switching going on when rates were moving last time, even though digital banking adoption was lower than it is today," he said.

Besides worrying about depositors shopping for rates elsewhere, bankers should be concerned about depositors hunting for yield within their institution, because moving money from one account to another is also much easier today than it was a decade ago, said Kamal Mustafa, chief executive of Invictus Consulting. Of course, rate hikes also mean fatter yields on loans, but Mustafa cautions that historical data may not be an indication of what to expect.

Beyond the depositors searching for yield, several observers say that the digital revolution has changed the way people view their banking relationship. Before, a high-yielding account may have been the only way a bank could differentiate itself from the bank across the street. Today, the online portal, mobile banking apps and personal financial management tools can widely differentiate one bank from the next.

"There is a much higher sensitivity to the customer experience and it is going to be interesting to see how interest rate sensitivity and user experience sensitivity play off each other when rates rise," said Josh Reich, co-founder and CEO of Simple, a digital-only "neobank" and unit of BBVA.

While Reich has a vested interest in people putting a greater premium on customer experience, consumers are judging their banks on more than just rate, said David Albertazzi, a senior analyst at Aite.

"Customer loyalty has changed and today you do find those customers who really look at experience," Albertazzi said. "And there are a lot of challengers to the banking industry who are recreating the banking environment fully digital with the user experience in mind."

As Reich describes it, the banks that are solely focused on attracting customers via rates "paint themselves into a corner."

That's one of the reasons why USAA is so focused on experience, said Francisco Robelo, its assistance vice president of savings assurance. The bank doesn't want to be one that people choose because they pay a high rate.

"What do you want to be known for in the marketplace? If you want to be known for yield, you're stuck for life," Robelo said. "Thinking that way is myopic."

Of course, consumers can have it both ways. They can maintain their main checking account — the one where they love the mobile app, use it to pay for Netflix and have bundled in a way that they can avoid fees in the post-free-checking world — and shop for rates with discretionary money that has been sitting and waiting for rates to rise.

"Psychologically, people associate their checking account with what they call 'the one I bank with,' and I don't see them changing that for rate," Geller said. "But there are definitely more opportunities to hop around now."